Mortgage protection insurance: When you might need it
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As a homeowner, you pay for homeowners insurance to cover a wide range of worst-case scenarios that can impact your property. Mortgage protection insurance (MPI) is a different type of safeguard that could be helpful if you’re unable to repay your mortgage. While that extra protection sounds good, MPI isn’t for everyone. Here’s when it might make sense for you.
What is mortgage protection insurance?
Mortgage protection insurance policies function as a type of life or disability insurance. The cost of the monthly premium varies depending on the amount of the mortgage, your age and your health. MPI policies in general only cover the principal and interest portion of a mortgage payment, so other fees like HOA dues, property taxes and homeowners insurance would still be your responsibility. You might be able to add a policy rider, however, to cover these expenses.
Some policies are designed to help those living in your home, or your loved ones, with making the mortgage payments in the event of your passing. For example, if you die with a balance on your mortgage and have an MPI policy, your insurer pays the remainder of the balance directly to your lender. Your partner or your heirs won’t have to worry about making the remaining payments or losing the home.
Some MPI policies are designed to help cover or reduce your monthly mortgage payments if you lose your job or face a serious disability that prevents you from working. The terms of these policies vary. For example, Bank of Montreal’s mortgage protection insurance for a disability can cover 50 percent or 100 percent of your mortgage payment for up to two years, and for a job loss, 50 percent or 100 percent of the payment for up to six months. Some policies have waiting periods, such as 30 or 60 days, before these payments are made.
Do you need mortgage protection insurance?
MPI is not required, and not always a financially prudent move.
You can get similar coverage through a sufficient life insurance policy by using the DIME (debt, income, mortgage, education) method, which takes into account your mortgage when you decide how much life insurance to purchase, explains Henry Yoshida, CFP, CEO and co-founder of Rocket Dollar, an Austin, Texas-based self-directed IRA and solo 401(k) provider.
To apply the DIME method (as outlined by insurance giant World Financial Group):
- Add up all of your outstanding debt, including your mortgage balance; your income; and the anticipated education expenses of your children.
- Subtract from that sum any existing insurance coverage you have in place. If there’s a surplus, you have enough coverage. If there’s a shortfall, that’s the amount of life insurance you should purchase.
Differences between MPI, PMI and MIP
Mortgage protection insurance (MPI) can easily be confused with another abbreviation, PMI, or private mortgage insurance. While the letters and terms for these insurance products are almost identical, they are distinctly different. As described above, MPI protects you; PMI protects the lender that loaned you your mortgage, and is required on conventional loans when the borrower puts less than 20 percent down.
To make all of this even more confusing, there is yet another acronym, MIP, which stands for mortgage insurance premium and applies to FHA loans. Like PMI, MIP protects the lender, not the borrower. However, unlike PMI, MIP cannot be removed on an FHA loan unless the borrower made a down payment of at least 10 percent.
Pros and cons of mortgage protection insurance
In general, mortgage protection insurance is only a good idea for people who can’t get approved for traditional forms of life or disability insurance, or for whom premiums for a traditional policy are cost prohibitive. If you’re in that situation, here are some pros and cons of mortgage protection insurance you should consider.
Pros of MPI
Your home is your most essential asset, so mortgage protection insurance can provide another layer of safety. The pros include:
- Guaranteed acceptance – Most MPI policies are issued on a “guaranteed acceptance” basis. That can be advantageous for people who have health issues and either have to pay high rates for life insurance or are struggling to obtain a policy.
- Peace of mind – Right now we’re in an uncertain economy. An MPI policy that will make payments after a job loss can make a big difference if you find yourself out of work.
Cons of MPI
Mortgage protection insurance is optional, and there are plenty of reasons to consider opting out or opting for the flexibility of a traditional life insurance policy instead.
- More cash out of your pocket – The MPI premium adds more of a burden to your monthly budget.
- Limited benefits in some cases – If your mortgage is nearly paid off or you paid for the home with proceeds from the sale of another home, paying for an MPI policy is generally not a good use of your money. Rather, that money could be stashed away in an emergency fund or retirement portfolio. Additionally, if you plan to make extra payments to pay off your mortgage early, you might not benefit as much from MPI because the loan payoff amount decreases as the mortgage is paid down. (However, some of the newer MPI policies include what’s known as a level-death benefit, meaning that the payouts won’t decline.)
- Potentially better alternatives – Because MPI is paid directly to your lender, it won’t provide any financial protection to your loved ones if you die other than paying off your mortgage. A life insurance policy might make more sense because the policy is paid to your beneficiaries, who can then decide how to allocate the money, whether it’s to the mortgage or elsewhere. For non-smokers in good health, life insurance premiums are generally lower than those for MPI, as well.
Where to buy mortgage protection insurance
If mortgage protection insurance feels like a good fit for you, it’s important to take the same approach you took with finding your actual mortgage. Comparison is key.
MPI is not as widely available as other types of insurance, so you might need to do some digging to determine which companies offer it. Evaluate the pricing and features of different MPI policies from a few insurance companies, and make sure you understand what the policy does and doesn’t cover before committing to it. While you’re at it, be sure to compare life insurance costs with that MPI policy — you might find one option is more suitable for your situation than the other.
How much does mortgage protection insurance cost?
The amount you’ll pay for mortgage protection insurance depends on a variety of factors including your age, how many years are left on your mortgage, the current balance of your mortgage, and the amount of coverage you desire.
We ran through a variety of scenarios using the U.S. Department of Veteran’s Affairs Veterans Mortgage Life Insurance calculator to give you a breakdown of what mortgage protection insurance could cost for a variety of scenarios.
For a mortgage with 20 years remaining until pay off, with a $500,000 balance and $500,000 of coverage:
- A 25 year old will pay $34.09 per month
- A 40 year old will pay $84.51 per month
- A 50 year old will pay $210.78 per month
- A 65 year old will pay $910.11 per month
For a mortgage with 10 years remaining until it’s paid off, a $100,000 balance and $100,000 of coverage:
- A 25 year old will pay $5.59 per month
- A 40 year old will pay $10.76 per month
- A 50 year old will pay $25.05 per month
- A 65 year old will pay $111.71 per month
As you can see, raising the amount of coverage, and raising the age of the person applying can increase the premiums significantly.